Paying for the bailout

As most everyone who reads TNL.net knows, the US is currently going through a pretty tough discussion about a $700 billion bailout for the financial system. There is much said around how the money ought to be used and what kind of controls should be put around it but one part of the discussion that seems to have been missing is how we’re going to pay for this.

$700 billion is a pretty large figure (TechPresident has a good post that puts it in perspective) and it’s one that will only increase the national deficit.

But interestingly, there’s a way to cover the $700 billion. If we are in a time of crisis, we all have to tighten up our belts: the president has said that the alternative is a really bad economy so I’d assume we are all in this together and we all need to pull in. With the figure of $700 billion being rougly $2300 per person, there’s no way we can ask for everyone to chip in that exact amount. But what if we decided to spread paying it back over several years.

So I started playing with the national budget simulator, a handy little tool which has older budget figures but can give us some ideas.

The first thing I did was repeal the Bush tax cuts from 2001 and 2003. If we are in an economic crisis, we have to figure out a way to get the country back on track so repealing tax cuts that were creating when the economy was arguably in a better state might do the job. Doing so against the 2006 Budget would have yielded $294.88 Billion. That gets up about a third of the way through paying for the bailout. So, if you repeal the 2001 and 2003 tax cuts over a 3 year period, you pay for the bailout. In times of crisis, that might work.

But that was the easy part. What if we need to pay for this in one shot. If that’s the case, we’d need to find another $400 billion in the budget:

Get rid of reconstruction aid for Iraq gets us $6.84 billion. With $80 billion in oil revenue currently running for the Iraqi government, we could argue they can cover their own reconstruction cost and eliminate this.

Cutting untaxed foreign profit would yield another $15.74 billion. You could argue that in times of crisis, we need to focus on internal profit and foreign profit is fair game.

a 20% cut in defense research and development would yield another $13.62 billion (from base of $68.129 billion) but slow down our ability to develop new weapons.

But those are all small cuts and other cuts could have negative impact on the economy so, looking at most of the budget, the only way to get anywhere near the $700 billion mark would be to repeal those tax cuts from 2001 and 2003. They were expensive then but are now downright unaffordable and one could argue that it would be our patriotic duty to cut them.

Ideas, comments, suggestions as to how to raise the $700 billion are welcomed in the comment thread.

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I have to be blunt. There are some people who are all for freedom, up until the point where someone makes a choice they don’t agree with. Then Something Must Be Done ™. Similarly, there are people who are all for free markets, until the market tanks. When the market is irrational on the upside, everyone finds all kinds of ways to justify it. When it tanks, then Something Must Be Done.

Here are some things that need to get cleaned up before we start talking bailout:

– Large markets without disclosure and central clearing. So when there are big moves, nobody knows who might go belly-up and the market stops functioning.

– Toxic lending structures, like option ARMs. If a broker puts a client in an unsuitable investment, they go to jail. If a mortgage broker puts someone in a borderline predatory loan, nothing happens.

– Fraud sentences for people who originated mortgages that had no chance of getting repaid, and those who securitized them

– Revisiting the ‘lender of last resort’ compact – the deal is, if you’re too big to fail and therefore deserving of a backstop, whether GS or AIG, you have to pay for that backstop, disclose your risks, and take prudent risks

Soros is on the right track (Google ft soros paulson blank cheque). Just offer the Buffett deal to any bank that wants it – all the money they need at 10%, in a preferred stock that gets paid off before stockholders, and convertible into equity at Friday’s price if the bank recovers and the stock goes up.

This will prevent widespread bank collapses. It won’t make everyone start lending again or prevent the natural course of the business cycle and the housing bust – what goes up must come down.

But the $700b ‘splurge’ won’t do that either – attempts to repeal the business cycle are futile, and we’ll just pay for it through higher taxes, higher inflation, less growth for much longer.

The question, though, is how many such big investors exist in the market and, even if you were to offer such deal, where would the money come from.

In the 90s, when Democrats entered the White House, all of a sudden, budgets HAD to be balanced. So assuming that that’s the case (and it’s really not a bad idea to think of balancing budgets) and going beyond the details of whether a bill is good or not (once again making an assumption as to something being needed), how do we pay for it. So the point I was trying to make in this post is that, if such bill is required, a parallel should be to repeal the previous large tax cuts to cover some of those costs. After all, that money is needed to deal with the crisis and repealing those cuts would be the quickest way to raise it without increase the national debt as much.

$700 billion (or $250 billion right now, if you believe the latest deals) is a lot of money and few people seem to be talking about how to pay for it…

I think the more interesting question is “where is this money going to come from”, and the answer to this is a bit scary. Plainly put, there isn’t $700B just sitting around under Washington couch cushions that can be thrown at this issue. If the Secretary will need $700B he will have to expand the money supply by initiating a massive issue of T-bills. Now M2 (since 2006, the most inclusive official measure of the US money supply) stands at only $7.7 trillion. So the plan, just to start, will require M2 to expand by over 9%.

This is likely to create a whole new slate of problems. For a start, in a market where credit is already nigh-impossible to obtain, could anyone actually sell $700B of new securities, no matter how “safe” these securities are? and what about the issue’s dilutory effects on the value of the USD?

Maybe I’m being naive here but I’m fairly sure that money doesn’t just appear because either the administration or Congress affirms that it will.

Actually, the money “can” appear by just printing more (ie. deflating the dollar) but as you point out, just dumping $700B into the market doesn’t mean it’s a good idea. Basically, in one shot we’re going to increase the national debt by 7 percent. So that’s why I was wondering about WHERE we should go in terms of finding some way to lower that impact. And that’s what got me thinking of ways to get to the $700 billion mark.

Initially, I was thinking about things like entitlement cuts but unfortunately, something like that would not only be unpopular, it could also have the impact of pushing more people into possible default on their mortgages… So the question then was where do we go: short-chaing infrastructure didn’t seem like a good idea, and touching the military budget, while possibly a smart move, probably wouldn’t sell in a time of war.

And then, there was the tax cuts. With the opening of “these are tough economic times,” I started thinking about what might happen if you cut it at several levels. If we truly have an emergency on our hands, a tax cut sacrifice might help…

So here is a question are we creating a new problem for ourselves if we can sell the bonds to get the money? what happens when they are called in. Is taxes not going to be less since the unemployment rate is going up which means less income taxes and more people getting the child tax credit. And on that note why are we giving them more money back then they ever payed into taxes? These companies that take the bailout money should be partitioned off and sold also to companies that have been responsible with the companies. Other wise what are we teaching them? that there is no consequences for irresponsibility?

If we do this right the bailout will pay for itself. The key unfortunately will land in the hands of the government deal makers (Paulson et. al). If the $700 billion is spent on assets at values that are below their final market value then the government will make money on the “bailout” (this happened in the Great Depression with the government owning mortgages themselves as apposed to mortgage backed securities). For example let’s say the government spends $700 billion on $1 trillion of face value MBS assets and then the recovery rate is around 75% (based on number of foreclosures/amount of restructuring to lower interest of the initial mortgages etc.) then your return on investment will be 75% * $1 trillion = $750 billion (over the course of decades). At which point the question is not the initial $700 billion (as mentioned that will come from basically printing money by selling various forms of U.S. debt), the question is did we have to pay out more than $50 billion in interest on the $700 billion dollar loan from China et. al. Or worse, what if the government spends $700 billion on assets that end up netting $500 billion (fairly pessimistic), even then the question is how do we pay for the $200 billion (plus interest) rather than how do we pay for $700 billion. Also, we’ll have the term of the loans sold (hopefully the government is wise enough to sell long term U.S. bonds) to pay for it. I agree with Tristan that repealing recent tax cuts is a good first step towards coming up with the cash but I think it’s important for everyone to remember that the raw $700 billion just comes from our fiat currency amount being increased and the long term financial issue of how much we have to come up with to pay down our national debt will be determined by the long term values of the assets purchased with the $700 billion.

One other thing. In my simple calculations I ignored inflation. If we print an additional $700 billion dollars of the US fiat currency then obviously inflation will have to be taken into account. My point still holds I think (so long as the government acts responsibly and we don’t go into hyperinflation). It really depends on the details though. If we have 10% inflation it only takes about 7 years for a dollar to lose half it’s value so…

But again, I agree with Tristan that we really need to talk about how to pay for this and taxes is obviously the right place to start as you don’t want to cut spending too much during a slowdown in the economy.

As you pointed out, the $700 billion would come from running the printing press on currency. This can have a couple of unexpected effects, though:

1. By putting more currency into play, wouldn’t we assume that this could create some extra pressure on the dollar. Granted, as a fiat currency, that pressure would only be based on perception, which brings me to the second point.

2. By dropping an extra $700 billion into the deficit, we’re going to approach a trillion dollar deficit. Will current holders of government debt and/or dollar currency consider that OK or will they start applying pressure on the dollar and other government related financial instruments.

Last but not least, if we assume that this release of $700 billion in extra dollars is happening, and we assume that this will put pressure on the dollar, we could find ourselves in a situation where the cost of import into the US would increase. Since a lot of US products are now manufactured overseas, this probably would result in increased inflation, which could put some extra pressure on the economy.

Well, right now even a “first step” of only $250B would result in a real annual deficit of about a trillion dollars (“official” deficit + this year’s bailouts + this year’s Iraq supplementals, etc.). I think the sort of gradual phase-in that’s made its way to the defeated-in-the-House proposal does somewhat address the issue of the overnight influx of new money into the overall market.

To be honest I don’t think much of the idea that the country will get its money back from the bailout or, as the President has suggested, that the country can *make* money from the plan (we’re all well aware of W.’s extensive business acumen, aren’t we). Sure it will get *some* money back, but if things were that simple as the bullish imply there would be no need for a bailout in the first place, would there. The situation would resolve itself with only a slight downturn. Looking at the bailout as an investment, it’s reminescent of some guy coming out of the blue and telling you that he can triple your money overnight, while constantly emphasizing that he needs to get the ball rolling NOW. The only thing you can be sure of when faced with such a situation is that you’re being scammed.

I’m a little ambivalent on this whole deal. On the one hand I think it’s a terrible idea in the long run. On the other hand I hope it passes this week so I can sell already-held US stock at a profit. The market is in for a serious correction whether there’s a bailout or not. The bailout will only move that big correction into Obama’s Presidency (or, God forbid, McCain’s). The whole point is that Bush and Paulson are desperately trying to avoid the crash being imputed directly to them. As for Congress, well, they’re happy when they spend money, and spend they probably will, what with all the pork that’s been added to the bill in the past week. The Bill, which started as a 3-page draft last week, was about 120 pages on Monday and has grown to some 450 pages by now so there’s something in there for everyone to like — except the taxpayer maybe…

The thing is that I don’t quite know what exactly will be achieved by spending all this money. People who are upside-down in their mortgages, for instance, will continue owing more than the property is worth. A man who makes $50k/yr will still not be able to afford to repay a $500,000 loan. You can give all sorts of extensions but that doesn’t change the fundamentals. Additionally the credit market will never get back to the insane highs of the early 2000s, just as a matter of common sense and lessons-learned. So, that $700B, what’s it going to buy?